No less an authority than Goldman Sachs CEO Lloyd Blankfein said at the Clinton Global Initiative last week that the United States could risk its status as the world's reserve currency if congress fails to act and the "fiscal cliff" program of spending cuts and tax increases is enacted January 1.

Actually Blankfein's statement was the reverse of the truth; enaction of the "fiscal cliff" program, halving the US budget deficit at a stroke, is one of the few outcomes that could AVOID the US losing its reserve currency status. But on the assumption that thepoliticians continue to misbehave after November 6, that trillion-dollar deficits continue, and the US does indeed over time lose its reserve currency status, what will a world without a reserve currency look like?

There is no relatively recent historical parallel we can examine to answer that question. The world has had the dollar as undisputed reserve currency since 1945, or really since 1939. Between 1914 and 1939 there were two reserve currencies, the dollar and sterling, with sterling more used in the 1930s than the 1920s, because that decade, once Britain went off the Gold Standard, was a period of robust health for the British economy, while the United States was mired in depression and isolationism. For more than a century before 1914, the world's undisputed reserve currency was sterling, although there were various regional alternatives.

To see a world with multiple reserve currencies, you thus need to go back to a world before sterling's sway, which in practice means before Britain's smashing victory in the Seven Years War (1756-63) took it to both military and economic supremacy.

The long-run goal of monetary policy is simple: Supply the economy with the right amount of money to promote healthy economic growth and a stable price level. Determining that amount is impossible for the Federal Reserve. Nevertheless, since 1971, when we said good-bye to the last semblance of a gold standard, we have delegated that responsibility to the Fed and the world’s central bankers. This 40-year experiment has failed. Real economic growth is faltering, and the world’s leading powers are waging a currency war in which success, perversely, is measured by the level of currency weakness rather than strength. What has happened to the idea of a sound dollar?

Because our monetary problems were decades in the making, we forget that over a very long interval (1834 to 1971), interrupted only by war, the US economy enjoyed tremendous economic growth and price stability, thanks largely to a convertible dollar (a dollar defined as a weight unit of gold). Numerous misperceptions about the gold standard keep this fact from today’s debate on monetary reform. Ask the average Washington insider, and he will tell you that the gold standard causes deflation and restricts economic growth. One need look no further than the historical record to understand that these criticisms are false.

Price stability, not deflation, was the hallmark of a dollar convertible to gold both in the 1800s and the pre-1971 20th century (see Charts 1 & 2). The US price level (CPI) was the same in 1914 as it was in 1834. The absence of inflation for almost a century did not come at the expense of economic growth. On the contrary! US real Gross Domestic Product (GDP) grew approximately 4% per year for that entire interval, the greatest period of growth in US history. Even during the period 1914 to 1971, as the gold standard was progressively diluted by the gold exchange standard, the residual link between the dollar and gold restrained the CPI, and promoted robust economic growth. After Nixon suspended convertibility of the dollar to gold in 1971, the CPI began its steep, modern-day ascent and the US economy, while continuing to grow, never regained the growth level and price stability seen from 1834 to 1971.

At the heart of the gold standard’s remarkable history of producing stable prices is the natural alignment of the long-run rate of growth of the above ground gold stock with global population and per capita GDP (see Chart 3). Over long periods, the three variables have grown in direct proportion to each other (0.6%-0.7% per year from 1810 to 1914; 1.4%-1.7% per year from 1914 to 2010). This symmetry is the primary reason why people have used gold as the natural monetary standard throughout history. There is an understanding, based on empirical fact and centuries of production history, that gold will not be overproduced or underproduced relative to population and per capita GDP. It follows, therefore, that when the dollar can be redeemed for a specified weight unit of gold, confidence in the dollar as a reliable measure of wealth increases. Price stability ensues.

At the October 5th Heritage “Conference for a Stable Dollar,” James Grant noted an important irony of the Gold Standard – when the dollar is defined as a weight unit of gold, individuals rarely exchange their paper money for gold. It is only in the absence of a gold standard that they desire gold, a store of value amidst fluctuating paper currencies. Said another way, when the dollar is “as good as gold,” people choose the convenience of the convertible paper dollar.

It is also true, however, that the desire and the freedom to hold gold by all market participants, not just the central banks, is a critical underpinning of the stability provided by the gold standard. Under the true gold standard (1834 to 1914), in the case where the central bank produces an excess of money relative to the economy’s demand for money, market participants will exchange their dollars for gold, and will continue to do so until the central and commercial banks reduce the supply of money such that price stability is restored. It is this spontaneous and automatic market mechanism, rather than the ratio of central bank gold reserves to the money supply, that keeps the price level in check. The gold standard is the solution to today’s monetary problems of currency chaos and financial market instability. While it is not perfect, no other system can match its long record of success in providing stable prices and superior economic growth. We have the map. Let’s use it.

The long-run goal of monetary policy is simple: Supply the economy with the right amount of money to promote healthy economic growth and a stable price level. Determining that amount is impossible for the Federal Reserve. Nevertheless, since 1971, when we said good-bye to the last semblance of a gold standard, we have delegated that responsibility to the Fed and the world’s central bankers. This 40-year experiment has failed. Real economic growth is faltering, and the world’s leading powers are waging a currency war in which success, perversely, is measured by the level of currency weakness rather than strength. What has happened to the idea of a sound dollar?

Because our monetary problems were decades in the making, we forget that over a very long interval (1834 to 1971), interrupted only by war, the US economy enjoyed tremendous economic growth and price stability, thanks largely to a convertible dollar (a dollar defined as a weight unit of gold). Numerous misperceptions about the gold standard keep this fact from today’s debate on monetary reform. Ask the average Washington insider, and he will tell you that the gold standard causes deflation and restricts economic growth. One need look no further than the historical record to understand that these criticisms are false.

Price stability, not deflation, was the hallmark of a dollar convertible to gold both in the 1800s and the pre-1971 20th century (see Charts 1 & 2). The US price level (CPI) was the same in 1914 as it was in 1834. The absence of inflation for almost a century did not come at the expense of economic growth. On the contrary! US real Gross Domestic Product (GDP) grew approximately 4% per year for that entire interval, the greatest period of growth in US history. Even during the period 1914 to 1971, as the gold standard was progressively diluted by the gold exchange standard, the residual link between the dollar and gold restrained the CPI, and promoted robust economic growth. After Nixon suspended convertibility of the dollar to gold in 1971, the CPI began its steep, modern-day ascent and the US economy, while continuing to grow, never regained the growth level and price stability seen from 1834 to 1971.

At the heart of the gold standard’s remarkable history of producing stable prices is the natural alignment of the long-run rate of growth of the above ground gold stock with global population and per capita GDP (see Chart 3). Over long periods, the three variables have grown in direct proportion to each other (0.6%-0.7% per year from 1810 to 1914; 1.4%-1.7% per year from 1914 to 2010). This symmetry is the primary reason why people have used gold as the natural monetary standard throughout history. There is an understanding, based on empirical fact and centuries of production history, that gold will not be overproduced or underproduced relative to population and per capita GDP. It follows, therefore, that when the dollar can be redeemed for a specified weight unit of gold, confidence in the dollar as a reliable measure of wealth increases. Price stability ensues.

At the October 5th Heritage “Conference for a Stable Dollar,” James Grant noted an important irony of the Gold Standard – when the dollar is defined as a weight unit of gold, individuals rarely exchange their paper money for gold. It is only in the absence of a gold standard that they desire gold, a store of value amidst fluctuating paper currencies. Said another way, when the dollar is “as good as gold,” people choose the convenience of the convertible paper dollar.

It is also true, however, that the desire and the freedom to hold gold by all market participants, not just the central banks, is a critical underpinning of the stability provided by the gold standard. Under the true gold standard (1834 to 1914), in the case where the central bank produces an excess of money relative to the economy’s demand for money, market participants will exchange their dollars for gold, and will continue to do so until the central and commercial banks reduce the supply of money such that price stability is restored. It is this spontaneous and automatic market mechanism, rather than the ratio of central bank gold reserves to the money supply, that keeps the price level in check. The gold standard is the solution to today’s monetary problems of currency chaos and financial market instability. While it is not perfect, no other system can match its long record of success in providing stable prices and superior economic growth. We have the map. Let’s use it.

Today the economic crisis we endure is only the latest chapter in the century-long struggle to restore financial order, the success (or failure) of which is inextricably bound up with American prosperity and the promise of the American way of life.

Between 2009 and 2011, we experienced an emerging market equity and economic boom. At the very same time, we experienced sluggish growth in the United States despite $3.5 trillion of Treasury and Federal Reserve subsidies to the banking cartel and favored corporations.

How could this be? The vast Fed credit creation of 2008 to 2011 could not be fully absorbed by the U.S. economy. Real economic growth was pre-empted by the drive for solvency and debt repayment.

It is too easy to forget that the newly created money by the Fed primarily flooded into U.S. stocks, bonds and the dollarized world of commodities, rescuing and enriching the banker and speculator class.

Excess Federal Reserve credit and money also cascaded offshore, igniting a fall in the dollar, and the emerging market financial and economic boom.

Fed-created money is not associated with the production of new goods, services and equities. Therefore, during the global market period in which the Treasury and foreigners spend the newly issued central bank credit, total purchasing power must exceed the total value of available goods and services at prevailing prices. Prices must rise when total demand exceeds total supply.

Sustained monetary inflation is hidden from the vast majority of working people. Over many cycles, the social effects of inflation, financial disorder and the overvalued dollar have intensified inequality in America.

The prudent middle class on Main Street is dispossessed; the reckless on Wall Street, bailed out. Without incentives to increase true savings, new investment will continue to depend increasingly on bank debt, leverage and speculation.

Ours is the latest ugly chapter in a century of inflation and financial disorder. But, there is a historic American solution.

Historical and empirical data show that gold convertibility of the dollar, without reserve currencies, creates the least imperfect monetary standard, generating economic growth and price stability over the long run.

Federal budget deficits and balance-of-payment deficits have radically increased since World War II. Today’s dollar has lost 85% of its value since 1971. Relative to gold the dollar has lost 96% of its purchasing power.

But America has experienced sustained inflation and deindustrialization because of the overvalued reserve currency role of the dollar, overvalued relative to other paper currencies, especially the Chinese yuan.

While China is an important trading partner of America, it may also be a mortal threat. The Chinese economy is subsidized and sustained by the pegged, undervalued, yuan-dollar exchange rate. Neither the United States nor China seem to grasp the long-term, destructive consequences of the world dollar standard. The Chinese financial system has been corrupted by tyranny, deceit, and reckless expansionism. But, like America, China is destabilized by the perverse workings of the world dollar standard.

Only monetary reform, including an end to the reserve currency system, can permanently correct the American, Chinese, and global disequilibrium. Without international monetary reform, the perverse effects of the dollar reserve currency system will continually metastasize into one financial and political crisis after another — even on the scale of the Great Recession of 2007–09. Currency wars, protectionism, and social instability will intensify.

Currently, China holds more than $3 trillion of official reserves and more than $1 trillion in U.S. government securities. These Chinese dollar reserves, earned by export surpluses, directly finance the American federal budget and balance-of-payments deficits. China has chosen to hold a significant fraction of its export surplus in the form of official dollar reserves. These dollars are promptly re-deposited in the U.S. dollar market, where they are used to finance U.S. budget and balance-of-payments deficits.